In the foreign exchange markets, like in many other markets, there are two basic types of trading environments – a trend and a range. A trend can be defined as a general move in one direction while a range is an oscillation in price between two broad levels. In stocks, we typically try to “buy low” (at a value) and “sell high”; this is actually the foundation of rangetrading. Currencies, however, trend more often than they range. Witness the near vertical move in the EUR/USD chart from 1.20 in January 2006 to 1.60 by July 2008 as prices climbed steadily with very little retracement. Trends can last for weeks, months and even years. As indicated in the chart below, it is much easier to look for opportunities to join a trend than to fight it.
KATHY lien &BORiS SCHlOSSBeRg
Directors of Currency Research, GFT In this report, we attempt to outline three simple methods to identify a trend: » Bollinger Bands » Moving averages » ADX
2006-2008 2006 – 2008
EUR/USD Rallies From 1.20 - 1.20 EUR/USD Rallies From 1.60
1.60 - 1.35 1.60 – 1.35
Remember that both stocks and forex trading involve risk. Forex trading is not conducted on a regulated exchange and as a result, there are additional risks associated with forex trading.
3 Ways to Identify a Trend
Bollinger Bands basically plot standard deviations above and belowa moving average. They were developed in the early 1980s by John Bollinger and are typically used to determine volatility. At GFT, however, we like to use Bollinger Bands to help us gauge a trend. In the chart below, we plotted a set of standard Bollinger Bands using the settings 20,2 (which mean two standard deviations away from the 20-day moving average) and then added a set of 20,1 BollingerBands (one standard deviation away from the 20-day moving average). This helps us to create our buy zone and sell zone. Typically, when an uptrend in a currency pair is very strong, it will remain in the buy zone, the zone between the upper Bollinger Band of two standard deviations and the upper Bollinger Band of one standard deviation, for some time. When the downtrend is very strong, the currencypair will remain within in the sell zone, the zone between the lower Bollinger Band of two standard deviations and the lower Bollinger Band of one standard deviation. If the currency pair closes below the buy zone or above the sell zone, we say that it has entered the range trading zone. Bollinger Bands are great tools to use to help determine when a currency pair enters or exits a trend. Forthose traders who like to pick tops and bottoms, a good way to do so is to wait for the currency pair to exit the buy or sell zones.
3 Ways to Identify a Trend
Moving averages is another great tool for identifying a trend in the currency market. By definition, moving averages track the average price of a currency pair over a specifiedperiod of time. A 20-day Simple Moving Average (SMA), for example, tracks the average price of a currency pair over the past 20 days. One way to identify trends with moving averages is to look for a perfect order. This occurs when all of the shorter term moving averages are above the longer term moving averages in an uptrend and the longer term moving averages are above the shorter term movingaverages in a downtrend. We usually see a new and powerful trend emerge when these perfect orders form after a period of range trading. Here is an example in the GBP/USD pair where moving averages are lined up in a perfect order. As you can see in the chart below, the 10-day SMA is below the 20-day SMA, which is below the 50-day SMA and those are below the 100-day and 200-day SMAs. We have also...